Review of World Economics

, Volume 137, Issue 3, pp 501–524 | Cite as

Parameter instability, superexogeneity, and the monetary model of the exchange rate

  • Guglielmo Maria Caporale
  • Nikitas Pittis


Parameter Instability, Superexogeneity and the Monetary Model of the Exchange Rate. — This paper argues that failure to test for parameter time invariance yields misleading results. Time heterogeneity other than unit roots will make the parameters of the unrestricted system unstable and statistical inference invalid. However, if the instability stems from a particular subset of variables (superexogenous with respect to the parameters of interest), conditioning on them results in a partial model with stable parameters, and standard inferential procedures can then be used. We apply this methodology to test the monetary model of the exchange rate and find that both system and single-equation estimates support it in the case of yen-dollar exchange rate.

C22 C32 F30 F41 


Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.


  1. Andrews, D. W. K. (1991). Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimation.Econometrica 59 (3): 817–858.CrossRefGoogle Scholar
  2. Baillie, R. T., and D. D. Selover (1987). Cointegration and Models of Exchange Rate Determination.International Journal of Forecasting 3 (1): 43–51.CrossRefGoogle Scholar
  3. Banerjee, A., J. J. Dolado, D. F. Hendry, and G. W. Smith (1986) Exploring Equilibrium Relationships in Econometrics through Static Models: Some Monte Carlo Evidence.Oxford Bulletin of Economics and Statistics 48 (3): 253–270.CrossRefGoogle Scholar
  4. Boothe, P., and D. Glassman (1987). Off the Mark: Lessons for Exchange Rate Modelling.Oxford Economic Papers 39 (3): 443–457.Google Scholar
  5. Boswijck, H. P. (1995). Efficient Inference on Cointegrating Parameters in Structural Error Correction Models.Journal of Econometrics 69: 133–158.CrossRefGoogle Scholar
  6. Corbae, D., and S. Ouliaris (1986). Robust Tests for Unit Roots in the Foreign Exchange Market.Economics Letters 22: 375–380.CrossRefGoogle Scholar
  7. DeJong, D. N., J. C. Nankervis, N. E. Savin, and C. H. Whiteman (1992). Integration versus Trend-Stationarity in Time Series.Econometrica 60 (2): 423–433.CrossRefGoogle Scholar
  8. Diebold, F. X. (1988).Empirical Modeling of Exchange Rate Dynamics. Berlin: Springer.CrossRefGoogle Scholar
  9. Diebold, F. X., and G. D. Rudebusch (1991). On the Power of Dickey-Fuller Tests against Fractional Alternatives.Economics Letters 35 (2): 155–160.CrossRefGoogle Scholar
  10. Engle, R. F. (1982). Autoregressive Conditional Heteroskedasticity with Estimates of the Variance of the UK Inflation.Econometrica 50: 987–1007.CrossRefGoogle Scholar
  11. Engle, R. F., and C. W. J. Granger (1987). Cointegration and Error Correction: Representation, Estimation and Testing.Econometrica 55 (2): 251–275.CrossRefGoogle Scholar
  12. Engle, R. F., and D. F. Hendry (1993). Testing Superexogeneity and Invariance in Regression Models.Journal of Econometrics 56: 119–139.CrossRefGoogle Scholar
  13. Engle, R. F., D. F. Hendry, and J. F. Richard (1983). Exogeneity.Econometrica 51: 277–304.CrossRefGoogle Scholar
  14. Ericsson, N. R. (1992). Cointegration, Exogeneity, and Policy Analysis: An Overview.Journal of Policy Modeling 14 (3): 251–280.CrossRefGoogle Scholar
  15. Frankel, J. A. (1979). On the Mark: A Theory of Floating Exchange Rates Based on Real Interest Differentials.American Economic Review 69 (4): 610–622.Google Scholar
  16. Frankel, J. A., and A. K. Rose (1994). A Survey of Empirical Research on Nominal Exchange Rates. NBER Working Paper 4865. NBER, Cambridge, Mass.Google Scholar
  17. Frankel, J. A., and M. L. Mussa (1985). Assets Markets, Exchange Rates, and the Balance of Payments. In R. W. Jones and P. B. Kenen (ed.)Handbook of International Economics. Amsterdam: North-Holland.Google Scholar
  18. Godfrey, L. G. (1978). Testing for Higher Order Serial Correlation in Regression Equations when the Regressors Include Lagged Dependent Variables.Econometrica 46 (6): 1303–1310.CrossRefGoogle Scholar
  19. Hansen, E. J. (1992). Efficient Estimation and Testing of Cointegrating Vectors in the Presence of Deterministic Trends.Journal of Econometrics 53: 87–121.CrossRefGoogle Scholar
  20. Harboe, I., S. Johansen, B. Nielsen, and A. Rahbek (1995). Test for Cointegrating Rank in Partial Systems. Preprint 5, Insititute of Mathematical Statistics, University of Copenhagen.Google Scholar
  21. Hargreaves, C. P. (1994). A Review of Methods of Estimating Cointegrating Relationships. In C. P. Hargreaves (ed.),Nonstationary Time Series Analysis and Cointegration. Oxford: Oxford University Press.Google Scholar
  22. Harris, D., and B. Inder (1994). A Test of the Null Hypothesis of Cointegration. In C. P. Hargreaves (ed.),Nonstationary Time Series Analysis and Cointegration. Oxford: Oxford University Press.Google Scholar
  23. Jarque, C. M., and A. K. Bera (1980). Efficient Tests for Normality, Homoskedasticity and Serial Independence of Regression Residuals.Economics Letters 6 (3): 255–259.CrossRefGoogle Scholar
  24. Johansen, S. (1988). Statistical Analysis of Cointegration Vectors.Journal of Economic Dynamics and Control 12: 231–254.CrossRefGoogle Scholar
  25. Johansen, S. (1991). Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models.Econometrica 59 (6): 1551–1580.CrossRefGoogle Scholar
  26. Johansen, S. (1992). Cointegration in Partial Systems and the Efficiency of Single Equation Analysis.Journal of Econometrics 52: 389–402.CrossRefGoogle Scholar
  27. Johansen, S., and K. Juselius (1992). Testing Structural Hypotheses in a Multivariate Cointegration Analysis of the PPP and UIP of UK.Journal of Econometrics 53: 211–244.CrossRefGoogle Scholar
  28. Kearney, C., and R. MacDonald (1990). Rational Expectations, Bubbles and Monetary Models of the Exchange Rate: The Australian/US Dollar Rate during the Recent Float.Australian Economic Papers 29: 1–20.CrossRefGoogle Scholar
  29. Kwiatkowski, D., P. C. B. Phillips, P. Schmidt, and Y. Shin (1992). Testing the Null Hypothesis of Stationarity against the Alternative of a Unit Root.Journal of Econometrics 54: 159–178.CrossRefGoogle Scholar
  30. MacDonald, R. (1988).Floating Exchange Rates: Theories and Evidence. London: Unwin Hyman.CrossRefGoogle Scholar
  31. MacDonald, R. (1990). Exchange Rate Economics: An Empirical Perspective. In G. Bird (ed.),The International Financial Regime. London: Surrey University Press.Google Scholar
  32. MacDonald, R. (1994). Long-Run Exchange Rate Modelling.IMF Staff Papers 42 (3): 437–489.CrossRefGoogle Scholar
  33. MacDonald, R., and M. P. Taylor (1991). The Monetary Model of the Exchange Rate: Long-Run Relationships and Coefficient Restrictions.Economics Letters 37: 179–185.CrossRefGoogle Scholar
  34. MacDonald, R., and M. P. Taylor (1992). Exchange Rate Economics: A Survey.IMF Staff Papers 39 (1): 1–57.CrossRefGoogle Scholar
  35. MacDonald, R., and M. P. Taylor (1993). The Monetary Approach to the Exchange Rate: Rational Expectations, Long-Run Equilibrium, and Forecasting.IMF Staff Papers 40(1): 89–107.CrossRefGoogle Scholar
  36. MacDonald, R., and M. P. Taylor (1994). The Monetary Model of the Exchange Rate: Long-Run Relationships, Short-Run Dynamics, and How to Beat a Random Walk.Journal of International Money and Finance 13 (3): 276–290.CrossRefGoogle Scholar
  37. McNown, R., and M. Wallace (1989). Cointegration Tests for Long-Run Equilibrium in the Monetary Exchange Rate Model.Economics Letters 31 (3): 263–267.CrossRefGoogle Scholar
  38. Meese, R. A. (1986). Testing for Bubbles in Exchange Markets: A Case of Sparkling Rates?Journal of Political Economy 94 (2): 345–373.CrossRefGoogle Scholar
  39. Moosa, I. A. (1994). The Monetary Model of Exchange Rates Revisited.Applied Financial Economics 4 (4): 279–287.CrossRefGoogle Scholar
  40. Pesaran, M. H., Y. Shin, and R. J. Smith (1997). Structural Analysis of Vector Error Correction Models with Exogenous I(1) Variables. Discussion Paper 9706. Department of Applied Economics, University of Cambridge.Google Scholar
  41. Phillips, P. C. B. (1990). Time Series Regression with a Unit Root and Infinite Variance Errors.Econometric Theory 6: 44–62.CrossRefGoogle Scholar
  42. Phillips, P. C. B., and B. E. Hansen (1990). Statistical Inference in Instrumental Variables with I(1) Processes.Review of Economic Studies 57: 99–125.CrossRefGoogle Scholar
  43. Phillips, P. C. B., and M. Loretan (1991). Estimating Long-Run Economic Equilibria.Review of Economic Studies 58 (4): 407–436.CrossRefGoogle Scholar
  44. Ramsey, J. B. (1969). Tests for Specification Errors in Classical Linear Least Squares Regression Analysis.Journal of the Royal Statistical Society B 31: 350–371.Google Scholar
  45. Sims, C. A., J. H. Stock, and M. W. Watson (1990). Inference in Linear Time Series Models with Some Unit Roots.Econometrica 58 (1): 113–144.CrossRefGoogle Scholar
  46. Spanos, A. (1990). Unit Roots and Their Dependence on the Conditioning Information Set.Advances in Ecomonetrics 8: 271–292.Google Scholar
  47. Stock, J. H. (1988). A Class of Tests for Integration and Cointegration. Kennedy School of Government, Harvard University. Mimeo.Google Scholar
  48. Taylor, M. P., and H. L. Allen (1992). The Use of Technical Analysis in the Foreign Exchange Market.Journal of International Money and Finance 11: 304–314.CrossRefGoogle Scholar
  49. Urbain, J.-P. (1992). On Weak Exogeneity in Error Correction Models.Oxford Bulletin of Economics and Statistics 54 (2): 178–207.Google Scholar

Copyright information

© Institut fur Weltwirtschaft an der Universitat Kiel 2001

Authors and Affiliations

  • Guglielmo Maria Caporale
  • Nikitas Pittis

There are no affiliations available

Personalised recommendations